For many years the due diligence investigation was carried out by the buyer, on the seller. However, with the new dynamics in our country, and the substantial increases in the buying of businesses in the SME market, it is often found that the buyer cannot raise the finances for the purchase, and often knows little about the business he/she wants to buy.

Perhaps we have gone from “let the buyer beware” to “let the seller be cautious”. This article is from the seller’s perspective.

The smart seller should control the process, especially for the following reasons:

The seller is disclosing sensitive information to the buyer,

The process takes up much of the seller’s management time,

The buyer is inclined to drag out the process, find out as much as he/she can – without an end in sight.

It is noted that only 30% of due diligence investigations end up in a transaction – so the usage of management’s time can be wasted, but more importantly the buyer is now in possession of confidential information which could be used to the detriment of the seller.

Therefore before committing himself/herself the seller must :

Set limits for the usage of management’s time and for the completion of the process.

Hold back information (especially off balance sheet matters) or camouflage flaws in the businesses make-up until he/she is satisfied that the buyer is really genuine and the price is within the ambit of the seller’s price.

Be satisfied that the buyer is really a buyer and not acting for the competition. The seller must be satisfied that the reasons for buying the business are within the ball park – such as obtaining growth, eliminating competition, diversifying the scope of activity of his/her present business etc.

Have a clearly defined mandate from the buyer’s representative stating that they have the right to negotiate a deal on behalf of the buyer.

Carefully review the buyer’s record and background. Background checks, civil and criminal on the buyer and its owners etc. is a wise move (with the consent of the buyer).

Get references on the buyer.

Check the financial record of the buyer. Is the buyer a legal entity – not a consortium?

Ensure that the proposed transaction is tax advantageous to themselves.

Verify the buyer’s ability to pay for the business – a letter of comfort from the financier would be first prize – stating that if a deal transpires and the financier is happy with the terms of the transaction, that the money to cover the purchase price is available. It is prudent not to give away too much information until the letter of comfort is tabled.

Must be satisfied that the business is structured to satisfy a genuine buyer – come with a clean ship to make the business more attractive.

I heard of transactions recently in the USA where buyers get a friend to make an offer much lower than the seller is prepared to sell for which the seller rejects. The real buyer now makes an offer much better than the previous offer by the friend, but nearer to what the seller is looking for – which the seller consents to. It appears to be an unethical practice, but is it good negotiating skills?

Another practice which is gaining a lot of momentum in the USA, and fast catching on in SA, is for the seller to insist on the sale agreement being signed first, but with a clause for a due diligence to be conducted – but only giving the buyer the right to negotiate a reduction in price if he/she finds things are wrong – but the transaction is still binding on the buyer – not a good practice for a buyer, but very good for the seller.

What buyers sometimes do not realise is that the seller, having built up the business has a passion for it – and doesn’t want the business to be destroyed by someone else – so the seller wants a competent buyer who understands the business. This is important when buying a family business.

The smart seller will get as close as possible to ascertain what the buyer is prepared to pay for the business – and what they is prepared to accept. Only then should the seller start releasing more information.

An important issue is that the seller must, when allowing the process to commence, ensure that information about the transaction is on a need to know basis – and staff are not aware of the possible deal. At the appropriate time they must be advised – but as 70% of investigations fail – hold back for as long as possible. Staff panic when they know a deal may materialise and they may be fired, and can destroy a deal.

The sale of the business is usually the best exit policy for the seller, so they will want to get the best deal possible – go for it.

This article is from the perspective of a buyer acquiring a small/medium size business. In recent years, there has been much emphasis on a seller’s due diligence on a buyer – to satisfy the seller that the buyer is really a buyer and can afford to pay the price. The seller’s due diligence will be covered in a separate article Continue reading DUE DILIGENCE – DIG DEEP